Capital Allocation Trends At Guangzhou Tech-Long Packaging MachineryLtd (SZSE:002209) Aren't Ideal

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Guangzhou Tech-Long Packaging MachineryLtd (SZSE:002209), so let's see why.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Guangzhou Tech-Long Packaging MachineryLtd, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.01 = CN¥7.1m ÷ (CN¥1.9b - CN¥1.2b) (Based on the trailing twelve months to September 2023).

So, Guangzhou Tech-Long Packaging MachineryLtd has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.0%.

See our latest analysis for Guangzhou Tech-Long Packaging MachineryLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guangzhou Tech-Long Packaging MachineryLtd's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Guangzhou Tech-Long Packaging MachineryLtd.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Guangzhou Tech-Long Packaging MachineryLtd, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 3.3% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Guangzhou Tech-Long Packaging MachineryLtd to turn into a multi-bagger.

On a side note, Guangzhou Tech-Long Packaging MachineryLtd's current liabilities are still rather high at 63% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Guangzhou Tech-Long Packaging MachineryLtd's ROCE

In summary, it's unfortunate that Guangzhou Tech-Long Packaging MachineryLtd is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 6.4% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 1 warning sign facing Guangzhou Tech-Long Packaging MachineryLtd that you might find interesting.

While Guangzhou Tech-Long Packaging MachineryLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.